Spin-Offs

1
Spin-Offs

• Spinoff A firm creates a subsidiary to hold a
  portion of its assets, distributes shares of its
  subsidiary to its shareholders to create an
  independent company.
• Two separate companies after the spin-off.
• No cash inflow to the firm from the spin-off.
  (Subsidiary is not being sold.)

2
Reasons for Spin-Offs

• Improved focus and reduction of negative
  synergies. Daley, et al (1997)
• Improved investment efficiency. Diversified firms
  allocate investment funds inefficiently.
  Ahn-Denis (2004).
• Reduction of information asymmetry.
  Krishnaswami-S(1999)
  .
• Ability to offer more effective incentive
  contracts to managers.
• Tax and regulatory-related reasons.
• Wealth transfer from bondholders. (Marriott)

3
Reasons for Spin-Offs (KS) Reduction of
information asymmetry. Krishnaswami-Subramaniam
(1999) (KS)

• the market value of ATT was being buried.
  Investors couldnt understand the strategy of the
  combined firm After the spin-off, ATT would be
  the biggest pure play in telecommunications.
  Investors will clearly understand it now.
  Robert Allen, then-Chairman of ATT, WSJ Sep 21,
  1995.
• independently traded shares of engineering
  unit would produce a higher overall valuation for
  Raytheon. Dennis Picard, CEO of Raytheon, WSJ
  March 6, 1995.
• Wall Street couldnt figure out how to value a
  9.5 billion company with one foot in a TV studio
  and other in a nuclear-waste dump. Business
  Week, Nov 25, 1996, p 38, article on
  Westinghouse spin-off.

4
Reasons for Spin-Offs (KS) Reduction of
information asymmetry. Krishnaswami-Subramaniam
(1999) (KS)

• In a spin-off no cash inflow to the firm.
• If a subsidiary (hence, the company) is
  undervalued, spin-off is appropriate since
  subsidiary is not being sold.

5
Reasons for Spin-Offs (KS)Measures of
Information Asymmetry

• Error in analysts forecasts of earnings.
• Absolute value of (Forecast EPS - Actual
  EPS)/Share Price
• Standard deviation of analysts forecasts of
  earnings.
• Normalized forecast error.
• (Error in analysts forecasts of earnings /
  Earnings volatility of firm)
• Standard deviation of (market-adjusted) stock
  returns around earnings announcements.
• Volatility of ( market-adjusted) daily stock
  returns.

6
Reasons for Spin-Offs (KS) Main Findings (Table
5)

• Firms that engage in spin-offs have higher
  levels of information asymmetry about their value
  than other comparable firms.
• Firms that engage in spin-offs have higher
  levels of information asymmetry about their value
  before the spin-off compared to after the
  spin-off.
• Firms with more growth opportunities and less
  internally generated capital are more likely to
  engage in spin-off, perhaps to mitigate
  information asymmetry problems
• before approaching the capital markets (Table
  10).
• Firms engaging in spin-offs raise capital more
  often and in
• greater amounts after the spin-off (Table 9).

7
Reasons for Spin-Offs Improved focus and
reduction of negative synergies. Daley, et al
(1997)

• Cross-industry spin-off Spun-off unit operates
  in a different industry than core line of
  business for pre-spinoff company.
• Same-industry spin-off Spun-off unit operates in
  same industry as the core line of business for
  pre-spinoff company.
• More value created in cross-industry spin-offs.
• (Table 2) Stock market reaction more positive for
  cross-industry spin-offs.
• (Table 3) Return on assets (operating
  income/total assets) (ROA) increases after
  spin-off in cross-industry spin-offs.
• (Table 6) ROA of parent improves but not of the
  spun-off unit!

8
Reasons for Spin-Offs Improving investment
efficiency. Diversified firms allocate
investments inefficiently. Ahn-Denis (2004)
Page 496 Excess value (Market-to-sales of
diversified company) minus (Weighted average of
market-to-sales of single-unit companies) Table
3 Pre-spinoff Negative excess
value. Post-spinoff Zero excess value.
9
Reasons for Spin-Offs Improving investment
efficiency. Diversified firms allocate
investments inefficiently. Ahn-Denis (2004)
How do we measure investment effectiveness? NPV
rule Invest if NPV gt 0. NPV PV of inflows
PV of outflows Tobins q Market value of
assets / replacement cost of assets. Invest if
qgt1. qgt1 NPVgt0 qlt1 NPVlt0
10
Reasons for Spin-Offs Improving investment
efficiency. Diversified firms allocate
investments inefficiently. Ahn-Denis (2004)

• Table 4, Panel C Capital expenditure/Sales
• Higher Capital expenditure/Sales post-spinoff
  compared to pre-spinofff.
• Much higher Capital expenditure/Sales
  post-spinoff for high-q divisions.
• No difference Capital expenditure/Sales for low-q
  divisions.
• Table 7 Positive correlation between change in
  excess value and change in investment efficiency.

11
Berger-Ofek (1999)

• Diversification is inefficient relative to a more
  focused strategy Bhagat, Shleifer and Vishny
  (1990), Lang and Stulz (1994), Comment and
  Jarrell (1995).
• What might be the role of market disciplinary
  forces, and internal governance mechanisms in
  spurring divestitures ? Table 3.

12
Herfindahl Index (H)

• H (Sum of sales-squared of all divisions) /
  (Square of sum of the sales of all divisions)
• Closer H is to one, more the firms sales are
  concentrated within a few divisions.
• Example
• Firm A 2 divisions, sales of 10 million each.
  HA (100 100)/400 .5
• Firm B 2 divisions, sales of 18 million and 2
  million. HB (324 4)/400 .82

13
Berger-Ofek (1999) Appendix B

• Return Stock markets response to announcements
  related to refocusing activities.
• Example Allegheny International 45.2 (wow!)
• Most returns are positive.
• Returns are most positive for refocusing done in
  response to financial distress (Table 9).